Misguided Incentives May Contribute To Rising Health Care Costs

Securing volume discounts from vendors and passing the savings on to health care providers is supposed to keep costs down, but purchasers may have an incentive to inflate prices.

They are funded by administrative fees based on a percentage of the costs of products purchased. Those fees would ordinarily be prohibited by the “anti-kickback” provision of the Social Security Act, but are allowed under a “safe harbor” exemption enacted by Congress in 1986, according to a report from the Government Accountability Office.

GAO examined the five largest group purchasing organizations (GPOs) and found that “administrative fees collected from vendors accounted for about 92 percent of their revenue in 2012, ranging from a low of 83 percent to a high of 98 percent.”

Among the practices that have been called into question are sole-source contracting, in which GPOs contract with only one vendor per product; product bundling, a requirement that providers purchase a specific bundle of products in order to receive discounts on certain purchases; and long-term contracts, which lock in pricing arrangements for five years or more.

Another source of concern is potentially lax oversight by the Federal Trade Commission. Although FTC officials told the GAO “that they continue to receive and review complaints each year about GPO contracting practices… the FTC has not initiated any enforcement actions directed at GPO conduct” since 2004.

Experts interviewed by the GAO are divided over whether GPOs are effective, with some claiming that they discourage innovation and fail to achieve significant discounts, while others contend that competitive pressure (there are over 600 GPO’s nationally) obviates those risks.

Critics claim that the fee-based funding structure of GPO’s “creates misaligned incentives for GPOs to negotiate higher prices for medical products in order to increase the amount of vendor fees that they receive,” and that vendors who rely on GPO contracts are unlikely to develop innovative products unless they are confident that GPO’s will purchase them. (RELATED: Obamacare Hiked Health Care Costs for Young Adults)

Supporters, however, point out that GPO’s use a competitive bidding process that “considers the ‘total value’ of a product or service for their customers, not necessarily solely the price.” In addition to “minimum levels of product quality, durability, and cost-effectiveness,” GPO’s consider a vendor’s product capabilities, and frequently include clauses in their contracts allowing them to “add additional vendors of the same product if the other vendor has innovative packaging.”

GAO concludes that, “there is little empirical evidence to definitively assess the impact of the vendor-fee-based funding structure protected under the safe harbor” because such data are not always properly reported.

The report recommends that the government “take steps to address any under-reporting that may be found,” but cautions that outright repeal of the safe harbor provision could cause “disruption while hospitals and vendors transitioned to new arrangements.”

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